Fiscal Expansions in North America

Fiscal Expansions in North America

Article excerpt

United States

According to the formal dating of the business cycle by the National Bureau of Economic Research (NBER), the US economy reached a peak of economic activity in December 2007, which marks the beginning of the US recession. While some economists tend to refer to a technical recession as two consecutive quarters of decline in real GDP, the NBER uses a broader definition of 'a significant decline in economic activity spread across the economy and lasting more than a few months, normally visible in production, employment, real income, and other indicators'. The committee pays particular attention to payroll employment, which has declined by 1.9 per cent since the peak reached in December 2007, allowing the unemployment rate to reach 7.2 per cent in December 2008, the highest rate since 1992. We expect a sharper decline in US employment this year, and see the unemployment rate reaching 10 1/2 per cent in 2010, the highest level since a brief peak in 1982.

Despite being in recession, real GDP (at least from the demand side) continued to expand in the first half of 2008, increasing by 0.5 per cent relative to the second half of 2007. However, output declined by 0.1 per cent in the third quarter of last year, and dropped sharply, by 1 per cent, in the final quarter of the year, according to preliminary GDP figures released after our forecast figures were finalised. This is broadly in line with our expectations, and figures in table 5 incorporate a decline of 0.8 per cent in the final quarter of 2008. The decline in output in the final quarter of the year is broadly based, reflecting a contraction in consumption of 0.9 per cent, declines in business and housing investment of 5.2 per cent and 6.5 per cent, respectively, and a drop in exports of 5.4 per cent, with the government sector and an unexpected rise in inventories providing the only source of growth in the economy. Import volumes declined for the fifth consecutive quarter, by 4.2 per cent, which will have a significant impact on global trade and output in the rest of the world.

Our central forecast figures reported in table 5 exclude the $825 billion fiscal package that President Obama is pushing through Congress as a matter of urgency in his first weeks in office. We expect the stimulus plan to be approved in the coming weeks, and have simulated the impact that this is expected to have on our forecast projections using our model, NiGEM. President Obama aims to introduce 80 per cent of the package within eighteen months. However, cost estimates produced by the Congressional Budget Office are slightly more cautious, and estimate that about $525 billion (more than 3 1/2 per cent of GDP) will be introduced in 2009 and 2010. We have used this as a guide for our simulation, and allow $275 billion in tax cuts, of which approximately $185 billion will benefit households and $90 billion will be received by firms, and $250 billion in government investment. The income tax rate is allowed to decline by 0.5 percentage points in 2009, and an additional I percentage point in 2010 before reverting to previous levels. We bring the corporate tax rate down by 9 percentage points in 2009, gradually reverting to base by the end of 2012.

As discussed by Barrell, Fic and Liadze (2009) on pp. 43-50 of this Review, the fiscal multiplier in the US is high compared to more open European economies, and spending measures affect the economy more rapidly than tax rebates. We estimate that the planned tax cuts will raise growth this year by 0.1 percentage points, and raise growth in 2010 by 0.6 percentage points. On top of this, spending measures are expected to raise US growth by 0.8 percentage points this year. Overall, with the fiscal package in place we project a decline in US GDP of 1.5 per cent this year and growth of 1 per cent in 2010. If the composition of the fiscal package is revised to include more in the way of tax cuts and less in the way of direct spending, more of the stimulus will be shifted from 2009 into 2010. …